January 2020 Kagiso Asset Management Quarterly - Curro - class of 2030 pg 1 Sappi skids from magazines to clothing pg 5 Fast fashion: if you're ...
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January 2020
Kagiso Asset Management
Quarterly
Curro - class of 2030 pg 1 Sappi skids from magazines to clothing pg 5
Fast fashion: if you’re not first, you’re last pg 9
www.kagisoam.com
1 Curro - class of 2030 Simon Anderssen
5 Sappi skids from magazines to clothing Abdul Davids
9 Fast fashion: if you’re not first, you’re last Sarah le Roux
13 Still lots of room at the inn Dirk van Vlaanderen
17 Performance table
Unconventional thinkingCurro - class of 2030
Simon Anderssen - Portfolio Manager
Every parent wants a better future for their child and
most are willing to make sacrifices to achieve this,
but the reality in South Africa is that very few can
afford to do so. With our consistently poor scoring in
global benchmarking studies, it is no secret that the
South African government school system is largely
in tatters.
1Curro - class of 2030
Curro is currently South Africa’s largest independent schooling More recently, increased learner numbers has largely come
operator offering a range of options for parents seeking from a lower-fee model called Curro Academy. Fees at these
feasible alternatives to public schooling. We discuss why we schools range between R1 900 to R2 900 per month. The lower
are positive about Curro’s prospects and believe its share is fees are achieved by having slightly larger classes, fewer
deeply undervalued. academic options in higher grades and less ancillary facilities.
Ready, aim, fire! The collective matric pass rate at the Curro Academies is high,
Curro is an entrepreneurial success story that began when a at 92.4% in 2019, compared to the national average of 81.3%.
group of schoolteachers started offering classes in a local church The success of this model is opening up a large new market of
hall. They went on to scrape together enough funding (including growth for Curro and there are now 13 of these Academies
their personal life savings) to build the first Curro school campus across the country.
in Durbanville, in the northern suburbs of Cape Town. Believing
The business of schools
that they were onto a good thing, they secured a long-term
Owning a school is capital intensive and a considerable amount
capital partner in PSG, the Stellenbosch investment company.
of money is invested before there are any learners sitting
Curro listed on the JSE in 2011, with a fantastical vision of behind desks. Thereafter, it costs the same to run a classroom
building 80 schools for 80 000 students by 2020. Six rights with one child in it, as it does with 20.
issues later, raising R4.6 billion in new equity capital, Curro
The Curro school business model is planned around a “J-curve”,
begins this decade with 76 schools and 63 000 learners.
which shows the progression of schools through time. The
Low-fee opportunity business approximately covers its costs, including teachers and
Curro offers a range of schools to meet different income levels. overheads, once it has 20 learners per class - regarded to be the
The original business model was centred around a school for breakeven point. Learner number 21 begins to generate a
mid-to-upper income families, with average fees of R4 500 per surplus to pay the capital providers, lenders and shareholders.
month. Today, there are 38 500 students attending this type of Ideally, classes will reach 30 learners. If a school is able, it may
school, compared to 10 000 learners in 2011. add another class to that grade, however, it is then back in the
Learner numbers per grade
7 000
2017 2018 2019 2020
6 000
5 000
Number or learners
4 000
3 000
2 000
1 000
0
R 1 2 3 4 5 6 7 8 9 10 11 12
Grade
Source: Curroposition where it has two unprofitable classes of just 15 to grow the number of learners at a school, it must first replace
learners until it can attract another 10 learners to the grade, the child whose family has chosen to emigrate or drop out.
and so on. This is made all the more difficult if the departing learner was
in grade 10, which is not a common entry point for learners
As the school grows, more capital is spent on employing
into a new school. Or, in the case of a family experiencing
additional teachers, improving technology, or upgrading
financial difficulties and if the learner is a good student, it
facilities. It is regarded reasonable to fund schools with a
may be prudent to offer the family a discount on fees as the
sizeable amount of debt to reduce the overall cost of funding.
incremental cost of a learner is low. Any additional fee revenue
In recent years, Curro has relied more on debt than shareholder
is positive, providing other families continue paying their
equity to fund its growth, which has led to higher interest
fees in full.
payments that have been a drag on profit growth. Nevertheless,
Curro initiated a dividend in 2018 - an indication of its maturing Programmed growth
business model. The weak economy has resulted in a slower than expected
growth rate in learner numbers at Curro schools. We believe
A slippery slope
these factors may continue to dampen growth, but there are
We would be naïve to suggest that private schooling is not a
clear indications that a reasonable level of increased learner
discretionary household expenditure item - many South African
numbers is somewhat assured over the next few years.
families do not even have the means to keep their children in a
government school. After years with little to no household Learner numbers at key entry grades, one and eight, paint an
income growth, mounting job losses, run-away electricity encouraging future picture. The chart on the previous page
tariffs and municipal rates, and uncertainty about the future, shows that learner numbers in these grades are higher than
households are particularly stretched. subsequent grades. Grade eight enrolmentments, in particular,
have increased significantly. If this trend continues and Curro can
Evidently, at the margin, this is not a positive environment for
retain the majority of its students in these grades, the knock-on
Curro’s revenues and any declines are magnified in profit
effect continues as successive years retain larger classes.
declines as fixed costs must still be covered. In order for Curro
Learner numbers and profitability increase over time
1 200 40%
Number of learners Profitability
35%
1 000
30%
25%
School profit margins
800
Number of learners
20%
600 15%
10%
400
5%
0%
200
-5%
0 -10%
1 2 3 4 5 6 7 8 9 10 11
Years since opening
Source: Curro and Kagiso Asset Management researchCurro - class of 2030
Historical performance provides a clear indication that Curro’s financial scale and breadth of operations are a strength
profitability improves as average class sizes increase. The chart when it comes to innovation. Launched in 2019, its DigiEd
on the previous page indicates that the average number of model provides learning through online tools and videos at
learners increases predicatably as the school ages. Profitability lower cost than its traditional schools. It builds on content
consistently improves as the school grows. from its best teachers and subject matter experts across its
schools. The DigiEd model is specifically designed to be an
Opportunity in a downward spiral
on-site learning model that maintains the social development
Because of the weak environment, now is a good time to buy
of learners. Longer operating hours also ensure that children are
schools. An organisation the size of Curro, with committed
safe and kept busy on campus during office hours for working
shareholders, access to capital and a valuable school
parents. The model has been very successful to date and three
management platform, is relatively well placed to weather the
new campuses will launch in 2020 with strong enrolments.
effects of weaker income growth and a stagnant economy.
Patience will be rewarded
However, this differs for ‘solo’ schools in the current environment,
Curro’s overall shareholder returns are not particularly
where single campus schools are not able to pool resources or
impressive at present. Investing in a host of new schools,
streamline costs across campuses. Furthermore, management
including buying seven in the last year, has caused debt to
structures migrate with the cohorts of learners through the
increase faster than its operating profit. This has left investors
school, as parents invest in the school when their children are
negative, with the share price at a multi-year low.
in attendance, but typically stop when their children leave the
school. Consequently, there is seldom a long-term orientation To mitigate concerns, management have scaled back on
in solo schools. In addition, if schools run into financial investment plans, choosing to expand only into existing
difficulty, this may result in the quality of education slipping, schools to accommodate the learner growth that is already
which in turn makes parents anxious. Students then leave, and ‘programmed’. It will also invest in recently acquired schools,
the school finds itself in a negative spiral. spending money where learner growth is practically assured or
where assets have been acquired inexpensively.
Curro has found an opportunity here, acquiring a number of
established schools for less than what it would cost to build a Given how schools are designed, it is no surprise that the
new school and carry it to a break-even point. Curro then current returns are low. Viewed as if it were one large school,
invests in facilities and staff, causing school confidence to Curro is currently operating at 70% capacity, which for a class
improve and learners to remain and even return - all indications of 30 learners, is 21 pupils. With the average age of a Curro
that are supportive of healthy returns on investment. developed school being 6.5 years, in school parlance this means
that Curro is still in primary school. Therefore, it is simply too
A digital future for schools
early to expect returns to be peaking.
Falling prices for devices such as iPads and laptops are
supporting a global trend towards digitally-enabled learning. Unless a better operator of independent schools steps into the
This ranges from distance schooling for all grades, to picture (unlikely in our view) or learners are lost to emigration
digitally-enabled classrooms. The spectrum of impact that the or unaffordability, today’s grade one Curro learner will be
internet and digital content is having on schools, is vast. There approaching matric in a decade’s time. Consequently, Curro
are many models across the world that are being trialed and, classes will be fuller, its economics will be significantly better and
while we don’t know what will work best for South Africa, it is shareholders with a long-term orientation will be richly rewarded
clear that the classroom of the future is very likely to look quite for taking advantage of todays depressed share price.
different to today.Sappi skids from magazines
to clothing Abdul Davids - Portfolio Manager
Originally a South African forestry and paper milling
company, Sappi is today a global leader in sustainable
woodfibre products and solutions. Their acquisition-led
global growth strategy, however, provides a sobering
view of how a company can misread its market,
destroying substantial shareholder value in the process.
Sappi’s South African business is therefore still their
biggest profit generator and a renewed source of
growth. We outline their journey.
5Sappi skids from magazines to clothing
From humble beginnings to an acquisition frenzy 1998 - Sappi lists on the New York Stock Exchange
Founded in South Africa in 1936, Sappi started producing pulp 2000 - acquired Potlach mill in the US for $480 million
and paper at a single mill in Springs, Gauteng. Over the following 2006 - acquired M-Real mill in Europe for 750 million euros
decades, Sappi invested in, and acquired, numerous mills and 2010 to current - acquired mills in Switzerland and Canada
farms around South Africa. They currently own and lease
Sappi’s current market value of only $1.5 billion is evidence
plantations in KwaZulu Natal, Mpumalanga and Swaziland -
that most of these acquisitions were ill-considered, leaving the
spanning 379 000 hectares.
legacy of a debt-laden balance sheet and a significant
In 1988 Sappi acquired Saiccor, which then was the world’s largest consequent interest burden.
producer of dissolving wood pulp (DWP). This is a purified cellulose
Sappi’s folly
pulp made from the cell walls of green plants (mainly from
Sappi’s glossy paper business accounts for half of its annual
eucalyptus trees). It is suitable for further chemical processing
sales, but only around 10% of its profits due to the weak
into a range of products and is either spun into textile fibres,
state of this business. Their acquisition spree in the glossy
processed into a film or regenerated into a sponge-like material.
paper department failed to identify the looming threat of
Between 1990 and 1997 Sappi expanded their international technological advancements, including the advent of
footprint, spending close to $3 billion on acquisitions outside of smartphones and tablets, which accelerated the decline in
South Africa: magazine and newspaper sales. The inevitable drop in coated
1990 - acquired five fine paper mills in the UK fine paper demand, coupled with the fixed supply of glossy
1991 - acquired Germany’s largest coated fine paper paper mills (overhead costs still need to be covered even if mills
producer (making Sappi one of the top European producers are running at a loss) resulted in an oversupplied market and
of coated fine paper used in magazines and brochures) lower prices for glossy paper (charted below).
1997 - Sappi shares listed in London, Frankfurt and Paris
Paper prices have declined from just above 900 euros per
1994 to 1997 - acquisitions mainly in North America resulted
tonne in 2000 to below 630 euros in 2017. Although prices for
in Sappi becoming the world’s largest producer of coated
coated paper recovered briefly in 2018/2019, following significant
fine paper
Multi-year decline in coated wood-free paper demand and prices
Total shipments EU coated wood-free paper price
8 1,000
7
900
6
Euros per tonne
5
Million tonnes
800
4
3 700
2
600
1
0 500
2012 2013 2014 2015 2016 2017 2018 2019 year 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 Sep 19
to Aug
Source: Bloomberg, Kagiso Asset Management researchclosures of paper capacity by European competitors, the price The chart below highlights the superior fibre properties of
trend resumed its decline in June 2019. DWP in viscose compared with cotton and polyester, indicating
why the viscose share of the total fibre market is expected to
In response to the rapidly declining market, Sappi’s current CEO,
grow at a faster rate than polyester and cotton. Currently,
Steve Binnie, embarked on a strategy to reduce unprofitable
viscose fibres only account for 6% of the total textile market
glossy paper capacity by diverting production to higher value,
(90 million tonnes per annum) in comparison to 63% for
niche paper grades and converting certain paper mills to
polyester and 25% for cotton.
produce DWP (in South Africa and North America).
Sappi has not only become the single largest producer of DWP
While Sappi has lost its leadership position in the glossy paper
but also one of the lowest cost producers, with production
market, these mill conversions have restored profitability to the
facilities in North America and South Africa. While their DWP
overall group and expanded its capacity in the faster-growing
business contributes only 20% to their sales, this amounts to
DWP market.
60% of profits due to the higher profitability of DWP compared
Clothing the world with DWP to paper. Expansions at Sappi’s production facilities at Saiccor,
Roughly 70% of DWP is used in the production of viscose staple coupled with mill conversions at the Ngodwana mill in
fibre (VSF) for the manufacturing of textiles. The other 30% is South Africa and the Cloquet mill in the US, have resulted in
higher quality dissolving pulp that is used in the production of their DWP production capacity increasing from around
acetate and ethers, which are in turn used in speciality 300 thousand tonnes in the early 1990s, to 1.4 million tonnes
applications. Viscose (made up of cellulosic fibres) competes for at present (charts on following page).
market share alongside other textiles, such as cotton and
Supply, demand and sustainability cycles
polyester. Compared to these, viscose scores well on all
Wood production has a clear cost advantage in South Africa
qualitative fronts, except for ‘wash and wear’ as it tends to be
and Brazil, which structurally benefit from fast tree maturity
weaker. This makes for a good blending textile, ideal for the
timelines because of temperate growing conditions. This
manufacture of apparel such as denims and sportswear.
results in a lower harvesting radius, and consequently,
Cellulosic fibre properties are superior to cotton and polyester for many textile applications
Viscose fibres Cotton Polyester
Applications
Cellulosic fibres
are superior
Durability û P PP to cotton and in
Absorbency P P û many respects
Function and
feel Breathability P P û differentiated on
sustainability
Softness P P P
Drape P û û Polyester is
Appearance Dyeability PP P PP superior on
Brightness/lustre PP P P straight/
durability
Renewable and biodegradable PP PP û versus cotton
Sustainability
Resource efficiency PP û û and cellulosic
Natural and attractive, Natural, functional fibres
Cheap, durable
Overall value proposition “greener” alternative and well and versatile
to cotton established
Non-wovens/technical textiles Home textiles Apparel PP Key strength P Qualities û Issue
Source: IHS Global, RISI, Hawkins WrightSappi skids from magazines to clothing
lower logistical costs for wood. Additionally, labour costs in the next few years as farmers increasingly favour competing
South Africa and Brazil are substantially lower than in Western crops that offer better economic returns. Supply may also come
Europe and the US. under pressure from the increased incidence of droughts or
floods across the major producing regions.
Dissolving pulp demand is a function of global viscose
production capacity and the supply of the alternative fibres. The trade war has hurt
The viscose market was stimulated in 2011 when cotton prices As indicated, the DWP price has risen steadily since 2011 - from
spiked due to cotton supply shortages. This increased the $800 per tonne then, to peak at almost $950 in 2019. However,
demand for viscose and dissolving pulp, resulting in a huge a perfect storm of rising viscose capacity coincided with a
increase in installed dissolving pulp capacity (dissolving pulp substantial decline in the Chinese textile market because of
demand was at two million tonnes in 2006 and almost five the tariffs imposed by the US on Chinese textile imports. The
million tonnes in 2016). result has been a precipitous decline in DWP prices to levels
below $650 per tonne. This has very negatively impacted on
China has continued to dominate global viscose demand,
Sappi’s profits and caused a commensurate drop in the Sappi
constituting 32% of demand in 2006 and 55% by 2016. In 2017,
share price.
this was negatively impacted by environmental restrictions
imposed in China due to poor environmental practices by Despite current DWP prices being very low, which appears
viscose producers in the country. Furthermore, Chinese unsustainable as an estimated 40% of DWP producers are
authorities added polyester to their list of ‘over-capacitated’ making substantial losses, Sappi should remain a profitable
industries, which has resulted in the idling of a substantial player in the DWP market. The outlook is dependent on how the
percentage of global viscose capacity over the last three years. situation is resolved, but it is our view that a normalisation in
global trade relations will bring about a rebound in the demand
Constraints on supply, changing consumer patterns and
for VSF from China and a corresponding increase in DWP prices.
improvements in the qualitative characteristics of polyester
Sappi is well positioned to benefit from this recovery.
has caused cotton to lose market share to polyester and
viscose. Cotton supply is expected to continue to decline over
Global DWP capacity estimates (2019) Price of Sappi’s key DWP grade product
1,000
Sappi
950
Rayonier
APRIL 900
Commodity
Sun Paper Speciality 850
US$/tonne
Birla
800
Lenzing
750
Bracell
GP 700
JARI 650
Stora Enso
600
0 200 400 600 800 1,000 1,200 1,400 2011 2012 2013 2014 2015 2016 2017 2018 2019E
Tonnes
Note: Commodity is viscose grade only and excludes fluff pulp
Source: Hawkins Wright Source: Prescient Securities, Kagiso Asset Management researchFast fashion: if you’re not first,
you’re last Sarah le Roux - Investment Analyst
For fashion retailers, speed and flexibility are
increasingly important. Instant gratification has
become the norm and clothing retailers are in a race
to bring the latest trends to market. As a result,
traditional bulk, bi-annual ordering is being replaced
by regular, small batch replenishment.
9Fast fashion: if you’re not first, you’re last
We examine why the accompanying quick response placed further pressure on local fashion retailers to refresh their
manufacturing (QRM) has been slower to take off in South Africa offering more frequently. However, shortening the buying cycle
and the implications for local fashion retailers. is not a simple task.
The fashion buying cycle Zara’s success with quick response manufacturing
The success of fashion retailers is determined by their ability to QRM is the process of producing smaller batches more frequently
accurately predict which colours, fabrics, prints and garment - where speed and adaptability is prioritised over cost. Zara is
styles are likely to be popular ahead of actual demand. Buyers for considered to be the most successful global example of quick
local fashion retailers travel to Europe and America to attend response retail (as indicated below) and has become renowned
fashion shows, visit stores and select samples. Combining this for the speed at which they are able to execute on the latest
research with lessons learnt from previous seasons, local fashion trends. Products tend to sell out before demand peaks,
retailers design their range and place orders with suppliers. incentivising their customers to visit stores more frequently to
avoid disappointment.
To minimise costs, the fashion buying calendar traditionally ran
over a six to nine-month period with only two major planning The key to Zara’s success involves vertical integration across the
cycles a year. Bulk orders were placed well in advance, but long value chain, from design through to end distribution into
lead times resulted in very little flexibility for these retailers stores. Core manufacturing facilities are located close to their
to react to changing customer preferences once the season distribution headquarters in Spain, allowing for the flexibility
had begun. required to introduce new designs to stores around the world
twice a week. It takes Zara less than two weeks to identify a
The rise of fast fashion has placed this model under pressure.
new trend and to have their own interpretation available in the
As fashion buying cycles worldwide have shortened and social
majority of their stores worldwide.
media has made it easier to identify the latest global fashion
trends, local consumers have come to expect more than last However, even for a leading fast fashion retailer such as Zara,
season’s winners from the Northern Hemisphere. The entrance relying solely upon the QRM model does not make sense.
of international fashion brands, such as Zara and H&M, has Around 60% of all Zara products are manufactured in close
Financial performance of the Zara brand over the last 15 years
18,000 25%
Sales Operating profit margin (RHS)
16,000
14,000 20%
12,000
Millions of euros
15%
10,000
8,000
10%
6,000
4,000 5%
2,000
- 0%
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Source: Inditex annual reports, Kagiso Asset Management estimatesproximity at a higher per unit cost. This is specifically the case manufacturers are largely unable to compete with Asian
for high fashion items that require speed and smaller batch manufacturers on cost. The sale of illicit imported clothing,
sizes to maintain a scarcity element and reduce the level of upon which no duty has been paid (or the value has been
markdowns needed to clear excess stock. The remaining 40% is understated), places additional pressure on retail pricing -
made up of low-risk basic items that inherently follow a more further impacting local manufacturers’ ability to compete.
predictable sales pattern. Low risk items can be ordered well in
Declining industry profitability and scale has led to a lack of
advance at a cheaper price, typically from low cost factories in
investment and a resultant loss of valuable skills. Consequently,
Asia. The net result is an enviable long-term track record of
the competency gap relative to international manufacturers
sales growth and profitability for the brand.
has widened over time. Local manufacturers generally lack the
The South African clothing manufacturing industry skills and machinery required to make technical pieces, such as
There are structural limitations to implementing QRM in those involving beadwork, or to work with more complex
South Africa. A lack of cost competitiveness in the face of cheap fabrics. For example, winter jackets and denim clothing are
imports and an absence of trade protection measures led to a almost exclusively imported. In short, the range of clothing
sharp contraction in South Africa’s clothing and textiles that can be produced at scale in South Africa is limited,
manufacturing sector during the 1990s. Over the last two particularly that which is made using locally produced fabric.
decades, clothing manufacturers have continued to struggle Therefore, even when local manufacturing is possible, fashion
despite government’s efforts to stem the decline (chart below). calls regarding the fabric to be used, largely need to be made
well ahead of the season.
There are very few fabric mills or dye houses left in the country.
As such, the bulk of material required for clothing manufacture Despite these challenges, the benefits of increased flexibility to
needs to be sourced in finished product form from overseas, adapt to changing trends in-season has begun to outweigh the
attracting import duties of up to 22%. When coupled with a additional cost involved. Although unit costs may be higher,
higher cost of labour and lower order volumes, local smaller order volumes reduce the amount of excess stock at
Decline in clothing and textiles manufacturing volumes in SA*
160
Seasonally adjusted index with a base year of 2015
2000: establishment
150 of SADC free trade 2005: clothing
agreement and AGOA and textile clusters 2008-2010:
established impact of global
140 financial crisis
130
2009: maximum
120 import duty on 2014: sustainable
clothing increased cotton cluster
from 40% to 45% established
110
100
90
80
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
*Textiles, clothing, leather and footwear
Source: Stats SA, SARS, Cotton South Africa, Kagiso Asset Management estimatesFast fashion: if you’re not first, you’re last
the end of season that needs to be sold at marked down prices. Vertical integration may not be the only answer, but it certainly
Therefore, on a net basis, profitability can be higher. appears to be paying off for TFG (chart below). Over the past
couple of years, TFG’s South African operations have gained
To own or to partner?
market share and achieved sales growth ahead of competitors,
The Foschini Group (TFG) is the only local fashion retailer that
while gross profit margins have been on the rise. This implies
is substantially vertically integrated into manufacturing.
that they are doing a better job (relative to their competitors)
Around 32% of TFG Africa’s apparel is manufactured locally, with
in tailoring their offering to actual consumer preferences.
22% produced by their own TFG Design and Manufacturing
supply chain. Their average lead time is six weeks and in-season What lies ahead
replenishment can be achieved within three weeks. The amount Ultimately, by forcing retailers to increase their proportion of
of apparel they will manufacture in South Africa is expected to locally sourced product, the shift to fast fashion and the
almost double over the next five years, with QRM as a proportion resulting need for QRM capabilities could prove to be the saviour
of own manufactured apparel increasing from 66% to 100% of the South African clothing manufacturing industry. Over
over this period. In order to achieve this, TFG has committed to time, technological advancements have the potential to bridge
investing a further R1 billion into local manufacturing. the skills gap, thereby further improving the attractiveness of
local production, provided there is sufficient investment over
Although Truworths, Mr Price, Woolworths and Edgars each
the medium term. Through the development of a clothing and
source a proportion of their product locally, they all rely on third
textile masterplan, government, trade unions and the private
party manufacturing relationships. Truworths has the highest
sector are actively working together towards this common
proportion of locally manufactured clothing (around 50%) and
goal. This presents a genuine opportunity to increase the
has been actively working with its South African supplier base
relevance of local manufacturing going forward and improve
to improve QRM. By sourcing locally, Truworths’ design team
the performance of those retailers who successfully embrace
can make colour and styling changes up to four weeks prior to
this opportunity.
delivery, although typically this occurs around 8-10 weeks prior.
In-season replenishment can be achieved within 3-4 weeks.
Sales performance of local fashion retailers
10% 49%
Woolworths Truworths Foschini Group Africa GP margin (RHS)
Foschini Group Africa Mr Price
8%
48%
6%
Gross profit margin
Sales growth
4%
47%
2%
0%
46%
-2%
-4% 45%
2017 2018 2019
Source: company results presentations, Kagiso Asset Management estimatesStill lots of room at the inn
Dirk van Vlaanderen - Associate Portfolio Manager
The South African hotel landscape boasts many large,
home-grown brands that have managed to remain
relevant despite the arrival of several international
hotel groups over the last 20 years. We discuss the
South African hotel industry, its challenges and
opportunities, and the outlook for two JSE-listed
entities - City Lodge Hotel Group and Tsogo Sun Hotels.
13Still lots of room at the inn
Hotel economics The South African hotel industry
Despite their terrestrial orientation, hotel economics are rather Locally developed hotel companies including Tsogo Sun,
similar to airlines in that they have a fixed number of openings City Lodge and Protea dominate the South African hotel
(rooms) that need to be filled. Revenue received by hotels is landscape. Sun International owns the iconic Sun City resort
therefore a function of the occupancy experience (how full and Table Bay Hotel, but the rest of its portfolio comprises
they are) and the rate charged per room. When demand mainly smaller hotels associated with its various casinos. The
(occupancy) is high, room rates will typically increase in tandem last 20 years has seen several of the large international hotel
to maximise the revenue from each available room - much like groups expand their footprint in South Africa:
the expensive last seat on an aeroplane. In times of weaker Marriot has been the most aggressive, acquiring
demand (lower occupancy), prices will typically decrease in an Protea Hotels in 2014 for $186 million. Some of its other
effort to fill as many rooms as possible. brands include the African Pride Collection and The Westin.
The International Hotel Group has presence with its
Like airlines, the cost base of hotels mainly comprises fixed costs,
Holiday Inn, Crowne Plaza and Intercontinental brands.
which are incurred regardless of occupancy, as shown below
Accor acquired the Mantis hotel chain in 2018 and owns
(left) for Tsogo Sun Hotels. This highlights that around 70% of
the Mercure hotel collection.
costs are fixed, with the largest being employee costs, property
The Raddison group of hotels includes Raddison Blu, Red
costs and depreciation. The variable costs would include room
and Park Inn.
expenses (eg laundry and cleaning), food and beverages.
For the 15 years post 1994, the hotel industry saw a steady
In South Africa, two-thirds of hotel bookings are business-related,
increase in new hotels opening, which was matched by a greater
therefore weekday occupancies tend to run at the 70%-80%
demand for rooms as the South African economy expanded at
level, while weekend occupancies average 40%. This results in
a healthy rate. This resulted in occupancies averaging 70% and
an average industry occupancy of around 60%.
the industry operating at strong profit margins. In the build up
to the 2010 FIFA World Cup, significant new capacity was
Tsogo Sun Hotels costs breakdown Available rooms and occupancy for SA hotel industry*
70 75%
Fixed Available rooms ('000) Occupancy (%)
65
70%
60
Admin fees
Employee costs 4% 65%
35% 55
Repairs &
maintenance 50
4% 60%
45
Depreciation &
amortisation Property costs 55%
9% 10% 40
Room expenses 35
11% Advertising 50%
6%
Food & Other 30
beverages 10% 45%
11%
25
Va
ri abl
e 20 40%
’06 ’07 ’08 ’09 ’10 ’11 ’12 ’13 ’14 ’15 ’16 ’17 ’18 ’19
*Combined City Lodge Hotel Group and Tsogo Sun Hotels rooms and occupancy as a market proxy
Source: company reports, Kagiso Asset Management estimates Source: company reports, Kagiso Asset Management estimatescreated, resulting in a 9% increase in total rooms available for Technology disruption
2008 and 2009. This coincided with a period of weaker OTA’s - friend or foe? Online travel agencies (OTA’s), for
economic growth in 2009 and, as a result, occupancies example Booking.com, Trivago, Agoda and Expedia, enable
plummeted to below 60% and hotel profitability contracted customers to book various travel-related products online -
materially (previous page right). but they charge a 15%-30% commission fee to the hotel
where the booking is placed. While these websites help
Demand remained healthy in the post-2010 period and little
hotels to fill rooms, the commissions significantly lessen the
new capacity was established. As such, occupancies began to
hotel’s profit per OTA-booked room.
rise as the market slowly absorbed this new capacity. Combined
with rising daily room rates (chart below), this saw hotel The convenience, user experience, higher marketing spend,
profits recover meaningfully from the 2011 lows. customer reviews and additional functionality means that
OTA’s are gaining the acceptance of customers, which
In the last three years, a new wave of capacity has come at a
presents a challenge for hotels. Globally, the OTA share of
time when the economy has slowed. Additionally, various other
total bookings for hotel groups varies between 15% and 25%,
temporary factors have contributed to a weaker demand outlook.
up from 5%-10% seven years ago. This has provided a
These include water shortages in the Western Cape, lower
significant cost headwind to hotel businesses.
government spend on travel, and new laws requiring minors
to travel with unabridged birth certificates (now reversed). The response from most hotel groups has been to push their
Consequently, the industry has seen occupancies revert to near own loyalty schemes and to try to capture direct bookings
trough levels once again, although room rates have still managed through their own websites. Hilton famously launched its
to increase, albeit at below inflation rates. We expect total hotel “Stop Clicking Around” campaign in 2016 to encourage more
room growth (new capacity) of 1.3% for the next three years, direct bookings.
which should be filled in a somewhat improved economic
To date, South African hotel operators have avoided extensive
environment. Therefore, we foresee occupancies normalising
use of these OTA’s, but we believe OTA’s are likely to be a
higher as some of these factors reverse.
source of hotel margin pressure in the future as South Africa
follows international trends.
Average daily room rate for SA hotels Airbnb - making the village bigger: Airbnb has added a new
dimension to the scale and variety of travel accommodation
available globally. It allows any of its members to list their
property for rental. Airbnb has seen a significant increase in
1,400
properties listed with over three million presently available
1,200 worldwide, which is rising daily. Locally, Cape Town alone
has 40 000 listed Airbnb properties.
1,000
Although we have seen only a partial impact of Airbnb on
800
the South African hotel landscape, we believe that it may
Rand
600 have a marginally more negative impact for the limited
service, budget and 3-star options - given that the services
400
and prices are more comparable.
200
0
2006 2008 2010 2012 2014 2016 2018
Source: PricewaterhouseCoopers 15Still lots of room at the inn
Local is lekker unbundling from the larger Tsogo Sun Gaming (casino) business
Two of South Africa’s largest hotel groups, Tsogo Sun Hotels and in July 2019, has resulted in Tsogo Sun Hotels now being a
City Lodge Hotel Group are listed on the JSE Securities Exchange. pure-play hotel owner and operator. While Tsogo Sun Hotels is
The table below highlights the number of rooms and various also dependent on the business traveller, it has a greater bias to
brands operated by the two companies. the Western Cape (50% of revenue) and the tourist market. Its
full-service offer caters well for larger groups and conferences,
City Lodge Hotel Group caters predominantly for the business
making it less dependent on the transient traveller than the
traveller, with a focus on a more affordable, no-frills offer. Its
City Lodge Hotel Group.
City Lodge and Town Lodge brands sit mainly within the 3-star
category, offering limited services such as restaurants and Although results outside of South Africa (14% of total rooms)
conference centres, while the Road Lodge caters for the have also been indicative of tough times, Tsogo Sun Hotels has a
cost-conscious traveller. well-established presence in Africa (ex-SA) and the Middle East.
Within South Africa, City Lodge’s hotels are predominantly Waiting for the cycle to turn
based in Gauteng, which houses around 50% of its rooms. The Both hotel groups have not been immune to South Africa’s weak
company has recently invested significantly into its African economic environment, with low occupancies and pressure on
footprint, with two new hotels in Kenya and one each in earnings. City Lodge Hotel Group has been more affected due
Mozambique and Tanzania. This has complimented the group’s to its higher business exposure and disappointing African
existing footprint in Namibia, Botswana and Kenya. The initial expansion. However, as both businesses are well-run, cash
trading of these new hotels has been disappointing, and the generative and have strong local brands, we believe that they
associated debt and related interest expense has seen group will benefit significantly from any improvement in occupancies
earnings compress significantly in recent periods. and room rates when these inevitably come to pass.
Tsogo Sun Hotels owns and operates a broad hotel portfolio
throughout South Africa, across a range of star grades. Its recent
Hotel brands by star grade
Tsogo Sun Hotels City Lodge Hotel Group
Total number of rooms:* 16,211 7,600
5-star
4-star
3-star
Budget
* Total number of internally managed rooms at company’s last reporting date
Source: company reports, Kagiso Asset Management estimatesKagiso Asset Management Funds
2 3
Performance to 31 December 2019 1 3 1 5 1 10 1 Since 1 Launch TER TC
year years years years launch
Unit trust funds 4
Equity Alpha Fund 23.1% 10.7% 7.3% 11.0% 16.4% Apr-04 2.19% 0.48%
SA Equity General funds mean 8.0% 3.4% 2.9% 8.4% 12.2%
Outperformance 15.1% 7.3% 4.4% 2.6% 4.2%
Global Equity Feeder Fund - - - - Not available Nov-19
Global Equity general funds mean
Outperformance
Balanced Fund 18.5% 9.8% 7.2% - 9.5% May-11 1.58% 0.46%
SA Multi Asset High Equity funds mean 9.5% 5.1% 4.8% 8.1%
Outperformance 9.0% 4.7% 2.4% 1.4%
Protector Fund 15.1% 9.6% 7.3% 7.5% 9.9% Dec-02 1.57% 0.35%
CPI + 4% 8.0% 8.8% 9.7% 9.9% 10.4%
Outperformance 7.1% 0.8% -2.4% -2.4% -0.5%
Stable Fund 12.5% 9.1% 7.9% - 8.7% May-11 1.51% 0.44%
Total return of CPI + 2% pa 6.0% 6.3% 6.1% 5.8%
Outperformance 6.5% 2.8% 1.8% 2.9%
Institutional funds5
Managed Equity Fund (SWIX) 24.6% 10.7% 6.5% 11.0% 11.7% Sep-06
FTSE/JSE SWIX All Share Index 9.7% 5.5% 4.8% 11.1% 11.1%
Outperformance 14.9% 5.2% 1.7% -0.1% 0.6%
Managed Equity Fund (Capped SWIX) 23.0% 9.8% - - 9.8% Jan-17
FTSE/JSE Capped SWIX Index 6.8% 3.5% 3.5%
Outperformance 16.2% 6.3% 6.3%
Domestic Balanced Fund6 18.3% 10.7% 6.8% 9.4% 8.8% May-07
Peer median7 7.1% 4.7% 5.0% 9.7% 8.7%
Outperformance 11.2% 6.0% 1.8% -0.3% 0.1%
Global Balanced Fund8 19.8% 11.4% 8.6% - 10.2% Jul-13
Peer median9 7.0% 5.3% 5.6% 8.2%
Outperformance 12.8% 6.1% 3.0% 2.0%
Bond Fund 10.6% 10.3% - - 9.2% Aug-15
BESA All Bond Index 10.3% 9.4% 8.2%
Outperformance 0.3% 0.9% 1.0%
Money Market Fund 8.4% 8.5% 8.3% 7.2% 7.9% Jan-04
Alexander Forbes STeFI Composite Index 7.3% 7.4% 72% 6.5% 7.4%
Outperformance 1.1% 1.2% 1.1% 0.7% 0.5%
Sharia unit trust funds 4
Islamic Equity Fund 10.7% 7.7% 6.4% - 10.9% Jul-09 1.43% 0.20%
SA Equity General funds mean 8.0% 3.4% 2.9% 10.0%
Outperformance 2.7% 4.3% 3.5% 0.9%
Islamic Global Equity Feeder Fund - - - - Not available Jan-19
Global Equity General funds mean
Outperformance
Islamic Balanced Fund 10.2% 6.6% 5.4% - 6.9% May-11 1.48% 0.15%
SA Multi Asset High Equity funds mean 9.5% 5.1% 4.8% 8.1%
Outperformance 0.7% 1.5% 0.6% -1.2%
Islamic High Yield Fund - - - - Not available Mar-19
Short-term Fixed Interest Index (STeFI)
Outperformance
Highest and lowest monthly fund performance Highest Lowest Highest Lowest Highest Lowest Highest Lowest Highest Lowest
Equity Alpha Fund 4.8% -5.5% 6.6% -6.0% 8.2% -6.0% 8.2% -6.0% 11.9% -9.0%
Balanced Fund 3.9% -4.8% 4.8% -4.8% 5.5% -4.8% - - 6.2% -4.8%
Protector Fund 3.3% -2.6% 3.3% -2.6% 3.4% -4.2% 4.8% -4.2% 9.5% -5.3%
Stable Fund 2.5% -1.3% 2.5% -1.3% 3.8% -3.5% - - 4.0% -3.5%
Islamic Equity Fund 3.4% -3.9% 5.3% -3.9% 7.3% -4.6% - - 8.1% -4.9%
Islamic Balanced Fund 3.0% -2.8% 4.0% -2.8% 4.6% -3.0% - - 8.2% -5.4%
17
Footnote and disclaimer follow overleaf.Kagiso Asset Management (Pty) Limited
Fifth Floor MontClare Place
Cnr Campground and Main Roads
Claremont 7708
PO Box 1016 Cape Town 8000
Tel +27 21 673 6300 Fax +27 86 675 8501
Email info@kagisoam.com
Website www.kagisoam.com
Kagiso Asset Management (Pty) Limited is a licensed financial services provider (FSP No. 784).
Reg No. 1998/015218/07.
Footnote: 1 Annualised (ie the average annual return over the given time period); 2 TER (total expense ratio) = % of average NAV of portfolio incurred as charges, levies and fees in the management
of the portfolio for the rolling three-year period to 31 December 2019; 3 Transaction costs (TC) are unavoidable costs incurred in administering the financial products offered by Kagiso Collective
Investments and impact financial product returns. It should not be considered in isolation as returns may be impacted by many other factors over time including market returns, the type of
financial product, the investment decisions of the investment manager and the TER. This is also calculated on the rolling three-year period to 31 December 2019; 4 Source: Morningstar; net of all
costs incurred within the fund and measured using NAV prices with income distributions reinvested; 5 Source: Kagiso Asset Management; gross of management fees; 6 Domestic Balanced Fund
benchmark returns are an estimate for December; 7 Median return of Alexander Forbes SA Manager Watch: BIV Survey; 8 Global Balanced Fund benchmark returns are an estimate for December;
9 Median return of Alexander Forbes Global Large Manager Watch.
Disclaimer: The Kagiso unit trust fund range is offered by Kagiso Collective Investments (RF) Limited (Kagiso), registration number 2010/009289/06. Kagiso is a member of the Association for Savings
and Investment SA (ASISA) and is a registered management company in terms of the Collective Investment Schemes Control Act, No 45 of 2002. Kagiso is a subsidiary of Kagiso Asset Management
(Pty) Limited [a licensed financial services provider (FSP No. 784)], the investment manager of the unit trust funds. Unit trusts are generally medium to long-term investments. The value of units
will fluctuate and past performance should not be used as a guide for future performance. Kagiso does not provide any guarantee either with respect to the capital or the return of the portfolio(s).
Foreign securities may be included in the portfolio(s) and may result in potential constraints on liquidity and the repatriation of funds. In addition, macroeconomic, political, foreign exchange, tax and
settlement risks may apply. However, our robust investment process takes these factors into account. Unit trusts are traded at ruling prices and can engage in scrip lending and borrowing. Exchange
rate movements, where applicable, may affect the value of underlying investments. Different classes of units may apply and are subject to different fees and charges. A schedule of the maximum
fees, charges and commissions is available upon request. Commission and incentives may be paid, and if so, would be included in the overall costs. All funds are valued and priced at 15:00 each
business day and at 17:00 on the last business day of the month. Forward pricing is used. The deadline for receiving instructions is 14:00 each business day in order to ensure same day value.
Prices are published daily on our website. Performance is based on a lump sum investment into the relevant portfolio(s) and is measured using Net Asset Value (NAV) prices with income
distributions reinvested. NAV refers to the value of the fund’s assets less the value of its liabilities, divided by the number of units in issue. A feeder fund is a portfolio that invests in a single portfolio
of a collective investment scheme, which levies its own charges and which could result in a higher fee structure for the feeder fund. Figures are quoted after the deduction of all costs incurred within
the fund. Individual investor performance may differ as a result of initial fees, the actual investment date, the date of reinvestment and dividend withholding tax. Kagiso may close a portfolio to new
investors in order to manage it more effectively in accordance with its mandate. Please refer to the relevant fund fact sheets for more information on the funds by visiting www.kagisoam.comYou can also read
